Friday, February 01, 2013

Costs are soaring, wages are going up, the labor force is shrinking and foreign direct investment (FDI) is going down in the world’s biggest manufacturing center — China. For decades China’s factories flooded the world with cheap goods, but the era of “cheap China” may be drawing to a close as low-cost manufacturing moves to cheaper countries such as Vietnam and Myanmar.

While some commentators say this will slow China’s growth, others say the impact may not be as big as predicted.

Economists like Louis Kuijs believe this is just part of the natural progression into becoming an advanced economy.

“It (China) is following the same path as Japan 50 years ago… only on a bigger scale,” the chief China economist for the Royal Bank of Scotland (RBS) says.

“What we are seeing today in China is low-end, labor-intensive manufacturing moving away from the coast, where wages have been rising by between 10 and 20 percent over the last decade, inland or out of the country altogether.”

A key indicator is FDI which fell last year by 4 percent, the first fall since the global financial crisis began in 2009.

The world’s second largest economy attracted $111.7 billion worth of FDI compared to $116 billion in 2011, well off Beijing’s target of $120 billion.

Another indicator is the working population — it is falling.

National Bureau of Statistics data show China’s working-age population –people aged between 15 and 59 — shrank by 3.45 million people in 2012. It is expected to continue falling on an annual basis until at least 2030.

In an article in the China Economic Quarterly last year, Wang Feng, director of Brookings-Tsinghua Center for Public Policy in Beijing, likened China’s demographic structure to a bullet train racing into the unknown.

“Profound demographic changes in China are redrawing the parameters of the country’s future,” Wang wrote.

Amitendu Palit, a visiting senior research fellow with the Institute of South Asian Studies, National University of Singapore, says the next wave of cheap manufacturers “might not come wholly out of China”.

He says countries like Vietnam and Cambodia are competitive in low-cost manufacturing while the Philippines is competitive as an outsourcing center.

“In the medium term, China will concentrate on shifting its comparative advantage from labor-intensive cheap products to high-value-added products. It has already identified the strategic industries in this respect and the transition might entail a period of lower growth by Chinese standards,” Palit adds.

There has been a concerted effort in recent years for China to move to the next level of its development, RBS’ Kuijs believes.

“The government has been a big advocate for Chinese businesses and industry to move up the value chain and to improve its industrial structure. Wages in China have been going up in recent years to levels where they are becoming a significant cost for manufacturers,” he says.

This means that the low cost, labor-intensive sectors have now become less attractive as an export base. These are sectors that do not require much in terms of technology, skills, supplier networks or infrastructure — such as apparel and footwear.

“The point about these industries is that they are highly mobile and don’t require a high level of machinery. So their cost competitiveness is basically wage costs,” Kuijs adds.

According to management consultancy Boston Consulting Group, wages are a growing component of manufacturing costs in China, making up to 30 percent of the total depending on the industry.

This means that certain activities are no longer economically viable in China and are moving either inland or out of the country altogether. They are activities China doesn’t mind let go because other sectors are rising rapidly.

Dong Tao, chief regional economist with Credit Suisse, non-Japan Asia, has said that around 30-40 percent of factories in China’s Zhejiang and Guangdong provinces have either closed or are considering closure.

Economists say countries like Vietnam, Bangladesh, Cambodia, Laos and Myanmar will gain from this movement of jobs and manufacturing.

“Although many countries can now compete with China on labor costs, it is countries elsewhere in Asia, able to take advantage of strong infrastructure and existing supply chain networks, that will be the main beneficiaries of China’s move out of low-end manufacturing,” says Gareth Leather, an economist with the independent research firm Capital Economics.

In an interview with CNBC recently, Leather singled out Vietnam as particularly likely to gain from a fall-off in China’s dominance.

“Moreover, given its proximity to China, Vietnam is able to benefit from existing supply chains,” he said.

While Vietnam’s labor costs are currently half those of China’s, they are rising quickly.

“The global textile industry is notoriously footloose, and it may not be long therefore before suppliers look for alternatives,” Leather added.

Meanwhile, emerging Europe has the advantage of proximity to the EU, hampered by relatively high labor costs.

In Africa, the reverse situation exists, with a thriving textile sector in countries such as Mauritius, but less developed supply chains. Mexico meanwhile benefits from proximity to the US, but suffers from low-productivity growth.

Leather added that losing out on low-end market share would not prove a “big deal” for China.

“The change reflects a shift by Chinese producers into sectors where margins are higher, such as digital products and automotive components, rather than a failure to compete,” he said.

Coronet, an Italian maker of synthetic leather with production in the southern Chinese province of Guangdong, plans a new factory in Vietnam to take advantage of lower labor costs. It will also be closer to customers in the shoe and handbag businesses, many of which have already moved there, Bloomberg reported recently.

Foreign capital helped build China into a low-cost manufacturing powerhouse and global growth engine. But its increasingly urban population now has higher expectations in terms of wages and working conditions with louder objections to the pollution that often comes with low-level manufacturing — demands that have eroded China’s cost advantage.

“We have noticed some migration by companies, but this is a normal migration. It’s not accurate to say there has been a large-scale shift of manufacturing (foreign investment) to other countries,” he said.

But he added, “You couldn’t say we are happy to see this development. We still hope to actively attract foreign investment.”

A survey of about 300 members of the American Chamber of Commerce in China found 58 percent believed the country remained in the top three investment priorities in 2012, up from 47 percent in 2011. But only 20 percent said China was their number one investment priority last year, compared to 31 percent in 2011.

Many are also looking at moving from China’s coastal manufacturing cities to its lower-cost inland regions.

A poll last year by the Federation of Hong Kong Industries showed that about 10 percent of Hong Kong companies located in China’s Pearl River Delta are considering a move to Southeast Asia due to rising costs, while 13 percent are considering moving to inland provinces.

HSBC economist Trinh Nguyen estimates that Chinese manufacturing wages rose by around 20 percent per year between 2005 and 2011, giving companies a strong incentive to start looking elsewhere for labor-intensive production.

“The total amount of capital flowing in China will be still robust, but the growth will decelerate. The nature of (foreign investment) will become more domestic market-oriented than export-oriented,” Nguyen said.

Shaun Rein, founder and managing director of China Market Research Group, and author of the book The End of Cheap China, says there is no doubt labor costs have been rising rapidly, forcing some light industries to relocate.

“Nike now produces more of its products in Vietnam than in China, for instance. But China manufacturing is not going to lose its dominance. We have seen instances of firms moving to other locations such as Indonesia and it didn’t work out,” he said in a recent interview.

“China’s skilled workers are more numerous and better than in other countries. Relocating all manufacturing out of China is not really an alternative for many companies.”

Rein believes more factory relocation within China will take advantage of lower land and wage costs. A case in point is how Nestle moved production facilities from Shanghai to Chengdu. Another is how Foxconn — the manufacturer of Apple’s iPhone — relocated 350,000 of its factory workers from Shenzhen in southern China to a new facility in Henan province, in the central part of the country.

“Relocating all manufacturing out of China is not really an alternative for many companies,” he said.